What Are UTXOs and Why Are They Important for Your Cryptocurrencies?

When you send or receive cryptocurrencies like Bitcoin (BTC), Cardano (ADA), Litecoin (LTC), or Bitcoin Cash (BCH), a series of complex processes occur under the hood. One of the key concepts to understand how these transactions are validated and managed is UTXO (Unspent Transaction Output).

Although you'll rarely see them directly or need to interact with them, UTXOs are the fundamental building blocks of how wallets work and how your transactions are ensured to be valid and secure.

What Are UTXOs Really? A Simple Analogy

Imagine you have a physical wallet and you receive cash. You don't receive a "balance," but rather individual bills and coins. If you have a 20-euro bill and want to pay for something that costs 5 euros, you don't cut the bill. You pay with the 20-euro bill, and you get 15 euros in "change" back in different bills and coins.

In the world of cryptocurrencies that use the UTXO model (like Bitcoin), it works similarly:

• Every time you receive cryptocurrency, what you receive isn't an "accumulated balance" in your account, but one or more transaction outputs that haven't been spent yet (UTXO).
• Each UTXO is like a digital bill or coin of a specific amount (for example, a "0.01 BTC UTXO," another "0.005 BTC UTXO," etc.).

Your "total balance" of Bitcoin is simply the sum of all the UTXOs that your wallet owns and can spend.

How Do UTXOs Work in a Transaction?

When you want to send cryptocurrencies, your wallet does the following:

1. Selects UTXOs as "Inputs": Your wallet looks for the available UTXOs you possess that, when summed up, are equal to or greater than the amount you want to send plus the network fee. It's like selecting the bills from your physical wallet to make a payment.
2. Creates New "Outputs":
   • One output goes to the recipient with the amount you want to send.
   • If the sum of the selected UTXOs is greater than the amount to send plus the fee, a second output is created: the "change," which returns to a new address in your own wallet as a new UTXO. It's like getting physical change back in your wallet.
3. The Original UTXOs Are Marked as "Spent": Once the transaction is confirmed on the blockchain, the UTXOs you used as "inputs" can no longer be spent again. They are "spent" and become part of the history.

Why Are UTXOs Important? (Even If You Don't See Them)

UTXOs are the silent engine behind the security and functionality of many cryptocurrencies for several reasons:

• Prevention of Double-Spending: By being unique and indivisible once spent, they ensure that the same amount of cryptocurrency cannot be used twice. This is fundamental for network integrity.
• Transparency and Traceability: Every UTXO can be traced back to its origin on the blockchain, allowing the legitimacy of all funds to be verified.
• Wallet Foundation: Your wallet doesn't store your cryptocurrencies; instead, it manages the private keys that give you the right to spend your UTXOs. It's the software that sums up all your available UTXOs to show you your "balance."
• Impact on Fees: Sometimes, having many small UTXOs can make your transactions slightly more expensive, as the transaction occupies more space by including more "inputs." Your wallet manages this automatically to optimize fees.

In summary, UTXOs are the individual pieces of cryptocurrency that your wallet owns and spends. Although they are a technical concept, they are essential for the security, immutability, and proper functioning of transactions in many of the cryptocurrencies you use daily.